Oct 9, 2012

Jeff Cook

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Blog Series: Equity Instrument Effects on Government Contractors

This post will be the first in a series regarding various equity instruments and their financial statement effects on non-public government contractor entities.

Government contractors are concerned now, more than ever, with recruiting and motivating employees. Many government contractors are using equity-based incentives to motivate employees.  Keeping these employees satisfied is your top priority, but also it is important to understand how that will affect your financial statements.

When you are considering the implementation of a share-based compensation plan in order to incentivize employees, there are two main categories of awards that contain several variations under them:   Equity Awards and Liability Awards.  The distinction between these two award categories is their classification on the balance sheet (equity section versus liability section).

The main differences in concluding how to account for these awards are as follows:

Equity Award (if all of the following are met):

1. Company intends and has the ability to settle the award by issuing shares of stock
2. The employee cannot have the ability to require the company to repurchase shares within six months of the date the restricted stock vested or the stock option was exercised

Liability Award (if any of the following are met):

1. The company intends to settle the award in cash
2. The employee can require the company to settle the award in cash; or
3. The employee can require the company to repurchase the shares within six months of the date the restricted stock vested or the stock option was exercised

It is possible that equity awards can, subsequent to award, become a liability if a contingent cash settlement event becomes probable of occurring, or if the company shows a history of settling awards for cash.

Generally, compensation expense for an equity award is measured on the date of grant at fair value and is not subsequently adjusted to reflect any changes in stock price.  Compensation expense for a liability award is based on the grant date fair value and then re-measured to fair value at the end of each financial reporting period (typically year-end).

Common types of equity awards include stock options, grants, and restricted stock.  Common types of liability awards include stock appreciation rights and phantom stock, although it is the substantive terms of the award and not the form that determine classification.

Subsequent blog entries will cover each of these types of awards in greater detail along with pros and cons of each and their effect on government contractors.

For more information, please contact Jeff Cook at 301.231.6200.